Public Bill Committee

[Frank Cook in the Chair]

(Except clauses 3, 5, 6, 15, 21, 49, 90 and 117 and new clauses amending section 74 of the Finance Act 2003)

Frank Cook: Before we commence this morning’s business, I ought to draw the Committee’s attention—this is perhaps more relevant to the Government side—to the fact that the timepiece above the door is way out, by about eight and a half or nine minutes. If Members are getting breathless and looking for a lack of extra time, they should use the annunciator screen clock.

Clause 61

Controlled foreign companies

Question proposed [22 May], That the clause, as amended, stand part of the Bill.

Question again proposed.

Jane Kennedy: It is a pleasure to see you back in the Chair, Mr. Cook, and I look forward to serving under your chairmanship this morning. Before I start, may I offer my best wishes to my hon. Friend the Member for Staffordshire, Moorlands and her husband, who I understand is poorly and in hospital? We send our best wishes to her and hope that her husband has a speedy recovery.
I would like to answer a number of the questions that the hon. Member for Fareham asked about the clause during the Committee’s previous sitting. I had a close look at what he said and hope to be able to respond to most of his concerns. The clause deals with an area that is the subject of intense interest and debate. Its specific role is to amend the controlled foreign company rules to block some tax avoidance schemes that were brought to our attention as a result of the disclosure legislation introduced in 2004.
Those rules are an important part of the UK’s defences against tax avoidance and are designed to prevent UK multinationals from avoiding UK tax on their profits by artificially moving profits to offshore companies that they control and that are based in low-tax countries. A number of highly artificial tax avoidance schemes that use partnerships and trusts have been marketed in an attempt to avoid the effect of the rules.
One of those avoidance schemes aims to enable a UK group of companies to sidestep the controlled foreign company rules by artificially diverting profits from the company to a foreign trust operated by the group. The clause will ensure that, where that happens, the profits remain within the scope of the controlled foreign company rules. Provisions are included to ensure that the income cannot be included more than once.
For a foreign company to be within the scope of the rules, it must be controlled by UK residents. Another scheme involves a UK group arranging for the majority of shares in one of its controlled foreign companies to be transferred to an unconnected party, even though all of its profits continue to belong to the group. The clause will ensure that, where that happens, the profits remain within the scope of the controlled foreign company rules.
The income of a controlled foreign company is exempt from UK tax when 90 per cent. of the profits in any one accounting period are distributed to the UK. A third scheme seeks to qualify for this exemption by meeting this distribution requirement using profits sourced from other accounting periods. Those profits carry overseas tax credits, which means that no UK tax will be paid on them. The clause will ensure that were that happens, the exemption is not available.
Finally, a foreign holding company of a UK group that owns trading companies that are exempt from the CFC rules will be similarly exempted when at least 90 per cent. of its income in an accounting period is made up of dividends from those trading companies. An avoidance scheme seeks to exploit that exemption by diverting income to a partnership in which the holding company has a majority interest. The company then claims that the income of the partnership does not belong to the holding company. The clause puts it beyond doubt that the profits do belong to the holding company for the purposes of the exemption so that, where that happens, the exemption is not available.
It is important to be aware that the clause is not intended to catch wholly commercial transactions. Nevertheless, where their use is driven substantially by commercial considerations, such arrangements should qualify for the motive test exemption. At our last sitting, the hon. Gentleman raised a number of questions. He probed around the definition of control and questioned whether we were taking further steps in that respect. The avoidance schemes targeted by the clause use highly artificial structures that are unlikely to be used for commercial purposes. Her Majesty’s Revenue and Customs has discussed these changes with representative bodies and is satisfied that few, if any, wholly commercial transactions will be affected by the redefinition of control. Nevertheless, as a back-stop, such legitimate arrangements will qualify for exemption from the control of foreign company legislation where their use is driven substantially by commercial considerations—the motive test exemption. In the unlikely event that the redefinition of control would bring a straightforward loan by a third party, such as a UK bank, to a foreign company within the scope of the rules, one of the exemptions—again, the motive test from the rules—would apply.
The hon. Gentleman asked me about the test for control—the definition of control and what had become accepted as the norm. The normal definition of control is based on both the power to direct how a company is run and the right to a company’s income. He emphasised the former of those two criteria. The test for control for controlled foreign companies in the current legislation is different and does not include a specific test based on the right to a company’s income. The clause introduces an additional test to counter a number of avoidance schemes where groups claim to be able to enjoy all the benefits of ownership of a controlled foreign company without being regarded as controlling that company under the existing definition. The change is therefore a reaction to the avoidance and is not related to any future changes to the rules that might emerge from the review of the taxation of foreign profits.
The wording used in the extended test for control mirrors closely that in the usual definition of control in section 416 of the Income and Corporation Taxes Act 1988. As in that section, income for the purpose of clause 61 is defined as the income of the company that is available for distribution to its shareholders. The wording used in the extended test for control is therefore consistent with other definitions of control in the 1988 Act. HMRC is not aware of any difficulties caused by the wording of section 416 and does not expect there to be any difficulties with the comparably worded clause 61.
The hon. Gentleman asked me what would happen when control changes during an accounting period. Provided that the company continues to be controlled by UK residents, under any of the tests available, it will be regarded as a controlled foreign company throughout the accounting period. If the company begins or ceases to be controlled by UK residents during the accounting period, the existing period will end and a new one will begin when the change of control takes place.

Mark Hoban: I am grateful to the right hon. Lady for giving way and for the detailed approach she is taking to the questions I raised before the recess. Regarding change of control during the course of the year, one of the points raised with me by one of the representative bodies related to the way in which income might accrue over the course of a year. Looking at control in the context of voting rights, that would change if more shares were issued or shares were transferred from one owner to another. In the present case, however, the issue is the rate at which income or distributable profits accrue over the course of the year. In our last sitting, I talked about fixed-rate preference shares. It may be that for part of the year income accrues in a way that would give control to one organisation—fixed-rate preference share holders—and accrue in a different way later in the year, which could shift control to the ordinary share holders. I wanted clarification from the Minister on control and change of control.

Jane Kennedy: I am about to come to some of the detail that the hon. Gentleman raised before the recess.
There are a number of ways for a person to have the power to direct how a company is run. It is not uncommon, under the existing test for control, for more than one person to be treated as controlling a controlled foreign company. In such circumstances, each person is treated as having control. There are separate detailed tests in the rules for determining how a controlled foreign company’s profits are to be apportioned to those companies that have an interest in the CFC. Where the complexity of ownership makes those tests inapplicable, the rules provide for the profits to be apportioned to such companies on a “just and reasonable” basis. The hon. Gentleman might argue that that is not an objective measure and that it could create uncertainty—indeed, I think he did so. However, I am sure that he accepts that “just and reasonable” is a widely used term in tax legislation—for example, it appears 53 times in the 1988 Act.
What is “just and reasonable” will depend on all the relevant facts and circumstances. Examples of “just and reasonable” apportionment and the factors to be taken into account can be found in the published guidance on the HMRC website. As promised, further guidance in support of the Bill and the clause will be published soon, probably during the summer recess—the usual practice in the event of an anti-avoidance measure being introduced. I think that the hon. Gentleman used an example of someone owning 60 per cent. of the economic rights but someone else controlling a different proportion of the voting rights. There are detailed tests for determining how a controlled foreign company’s profits are to be apportioned. The answer that I gave to the hon. Gentleman about “just and reasonable” apportionment—that the matter would be considered on a case-by-case basis—would, I am sure, reassure those who would be advising in such cases. There are detailed examples, and further information can be obtained from HMRC.
Only where clause 61 applies will it be necessary to divide an accounting period into the period before and the period beginning on or after 12 March. Because the clause is targeted at highly artificial tax avoidance schemes, there will be a division into two periods only for schemes designed for the purposes of avoidance. If there are two accounting periods, dividends received after 12 March 2008 will be treated as arising after that date. A charge to UK tax on the income of a controlled foreign company will arise only where that company exists to avoid UK tax, since the motive test exemption will otherwise prevent such a charge. The clause does not have effect before 12 March 2008. It will not increase chargeable profits before that date, so there will be no need for companies to reconsider what dividends need to be paid to pursue an acceptable distribution policy for earlier periods.

Mark Hoban: Will the right hon. Lady confirm that if a dividend is paid after 12 March 2008 and it is 90 per cent. of the income of the CFC for an earlier accounting period—say, to 30 September 2007—the company will not have to recalculate the acceptable distribution policy?

Jane Kennedy: I believe that that is correct. I will take advice, and if I am wrong I will certainly communicate that to the hon. Gentleman and the Committee. I believe that what he said is in line with my response to his earlier questions. Under the clause, the cumulative income for the entire accounting period would be examined when determining control of the company. This is a complex matter and I have given considerable thought to the points that he made at the start of the clause stand part debate.

Mark Hoban: Will the right hon. Lady take the opportunity of this discussion about controlled foreign companies to clarify the status of the consultation? A question that was raised with me was why this is being done in the Finance Bill 2008 when further legislation on CFCs is expected in the Finance Bill 2009—although press reports suggest that people are now talking about the Finance Bill 2010. The Committee would be grateful for clarification on the record of when the Treasury thinks that legislation will be introduced, as this matter is causing a great deal of uncertainty in the business community.

Jane Kennedy: The hon. Gentleman is in danger of taking me wider than the clause. However, I am happy to put it on the record that the purpose of the business group that I will chair is to enable Ministers and officials in the Treasury and HMRC to engage with a representative group—not people who are representatives, but a representative group—of British multinational corporations to consider further the work that has been done and the proposals in the public arena on controlled foreign companies. We must ensure that any consultation paper is right for the circumstances of the British economy. As chair of the group, it is my intention to encourage discussion that will enable businesses to share their experiences and opinions and for myself as a Treasury Minister and officials to benefit from the advice and experience that they will bring.

Mark Hoban: Does that mean 2009 or 2010?

Jane Kennedy: I was careful not to be specific and I do not intend to be any more specific. I am looking forward to working on this subject. I know that we will debate it further in the course of our consideration of the Bill and on other occasions. For today, what I have said is sufficient.

Mark Hoban: I thank the Financial Secretary for her detailed responses to most of my questions. She gave a non-specific response to my final question—I think I heard the sound of the ball being kicked into the long grass—but she has provided some very important clarification on the functioning of the clause. I appreciate that it is designed to tackle particularly complex and artificial arrangements. She has assisted practitioners’ understanding of the detail. On issues such as income, it would have been helpful to have the definitions that she used in the clause. Perhaps she will consider inserting them on Report.

Question put and agreed to.

Clause 61, as amended, ordered to stand part of the Bill.

Clause 62 ordered to stand part of the Bill.

Clause 63

Repeal of obsolete anti-avoidance provisions

Question proposed, That the clause stand part of the Bill.

Mark Hoban: We will not oppose the clause, which will introduce some welcome simplification to the tax system. I understand that the changes have the support of those who have been consulted, but I want to ask the Financial Secretary about process. One measure that will be repealed by the clause relates to changes that were made in 1997. A burden was presumed to be imposed upon exempt bodies, despite the fact that they lost the right to reclaim tax credits They were required to submit returns annually for something that they could not reclaim. There was a cost attached to that and they had to do it for no apparent purpose. Is a proper process in place to ensure that where changes are made to the tax system, they flow through so that no burdens that have no attached purpose are left hanging around?

Jane Kennedy: The clause repeals a number of provisions relating to shares and securities, and is particularly relevant to companies such as banks, insurance companies and others that deal in shares and securities as part of their business. The hon. Gentleman refers specifically to repeals of provisions dating from 1997, but they are mostly about the exploitation of tax credits on dividends and the creation of losses. Tax credits on dividends are no longer payable to companies, so the protections given by those rules are not needed. Since 1995, such companies have not been able to create losses in the way that they used to. All of the provisions repealed are almost entirely redundant.
The hon. Gentleman asked about process. I confess that I am not clear what point he is making. We involved the industry before making the proposals on repeals.

Mark Hoban: My point was connected with exempt bodies, and relates to companies that bought shares with dividends and generated a trading loss. There are exempt bodies that have had to continue to submit returns without being able to reclaim the tax credits. The change should have gone through in 1997 when the laws on tax credits were changed, yet provisions have been in place until this year’s Finance Bill. My question about processes is why was that change not put through at the time and why has the provision remained on the statute book for so long? There is no benefit to the exempt bodies and submitting the returns is a cost to them, and there is no benefit to the Exchequer from having the returns submitted annually.

Jane Kennedy: That is a good question. I am not in a position to answer, other than to say that the purpose of the anti-avoidance simplification review is to examine legislation to ensure that we remove from the statute book rules and legislation that is unnecessary. All that I can say is that I introduced the measure at the earliest opportunity.

Question put and agreed to.

Clause 63 ordered to stand part of the Bill.

Clause 64

Income of beneficiaries under settlor-interested settlements

Question proposed, That the clause stand part of the Bill.

Philip Hammond: The clause corrects an unintended consequence of changes made in the Finance Act 2006—here we go again, Mr. Cook—to the way in which the income of beneficiaries of certain trusts is taxed. Where the income or assets of a settlement can be paid or used to benefit the settlor, settlor’s spouse, civil partner or unmarried minor children, the income is taxed as if it was that of the settlor, even if it is not paid or applied in that way. Those types of settlements are known as settlor-interested settlements.
The Finance Act 2006 changed the way in which the settlor was charged on that income: trustees now pay tax on the settlement income at 32.5 per cent. on dividend income and at 40 per cent. on all other income, and the settlor gets a credit for the tax that the trustees have paid. If a beneficiary who is not included in the group of people I listed receives a discretionary payment from a settlor-interested trust, the beneficiary is also taxable on the payments.
Provisions introduced in the Finance Act 2006 provided that, as the settlor has already been taxed on the income, the discretionary beneficiary is given a non-refundable tax credit of 40 per cent. Under the present rules, income from a trust is taxed before savings and dividend income—apparently, that is known as the statutory ordering. The effect of the ordering provisions is that a beneficiary may be chargeable to a higher rate of tax on other savings or dividend income than they would otherwise be liable to where they also receive income a settlor-interested trust. Apparently, that was not the intended impact of the measure.
The clause proposes that the trust payments be treated as the highest part of the beneficiary’s income, except in respect of top-slicing relief on income gains from life insurance contracts. If my understanding is correct—the Financial Secretary will be able to confirm this—that effectively sets aside the provisions of schedule 1 in relation to the starting rate of tax on savings and the ordering provided in relation to that in the Income Tax Act 2007, as amended by schedule 1.
The changes are backdated to 6 April 2006. That is supposed to ensure that beneficiaries are not disadvantaged by the mistake in the drafting of the Finance Act 2006. I should be interested to know when the problem was first spotted and why we have had to wait two years for a correction. It may not have been identified until tax returns in respect of 2006-07 were received and processed—I hope that the Minister can confirm that that is the case. Some sort of quality audit process is needed, particularly in relation to Finance Acts, so that when things go wrong and have unintended consequences. some attempt is made to analyse the process and to ensure that we get it right the next time.
The Institute of Chartered Accountants has raised a second anomaly which it says it raised with the Government back in 2006. Although the Government have addressed one problem in clause 64, they have not dealt with that second anomaly. Will the Financial Secretary turn her attention to the fact that including a discretionary payment from a settlor-interested trust in the net income of a non-settlor beneficiary who is entitled to age-related allowance will adversely affect that beneficiary’s entitlement to age-related allowance? This is a person who is not included in the list of settlor, settlor’s spouse, civil partner or unmarried minor children. This is another beneficiary who receives a discretionary payment from a settlor-interested trust. Because he is otherwise entitled to age-related allowance, that entitlement will be adversely affected.
Where this adverse effect occurs, the payment will effectively be taxed twice: once in the hands of the settlor, as is intended by the legislation, and again in the hands of the non-settlor beneficiary who would otherwise have been entitled to age-related allowance. Such income is also taken into account when assessing the beneficiary’s entitlement to tax credits and pension credits. This seems unfair and probably an unintended consequence. Can the Financial Secretary tell the Committee whether she is aware of this issue, what representations she has received about it and why it has not been addressed along with the perhaps rather larger error that is being addressed in clause 64?

Kitty Ussher: Welcome back to the Chair, Mr. Cook.
The hon. Member for Runnymede and Weybridge asked whether his understanding of the clause is correct. It seems to me broadly correct, although he mentioned that he thought there was a relationship between the clause and schedule 1. I just wanted to clarify that it has no effect on schedule 1 of the Bill or any ordering provision. Apart from that, my understanding is the same as his.

Philip Hammond: Will the Financial Secretary give way?

Kitty Ussher: Economic Secretary, but I will give way.

Philip Hammond: Sorry—Economic Secretary. The shuffling of jobs gets more and more confusing.
My understanding was that schedule 1 amends the ITA 2007 in order to define the ordering for the purposes of the starting rate of tax on savings. This provision deals with the ordering in respect of payments to non-settlor beneficiaries from settlor-interested trusts and puts them at the top of the pecking order, as it were, as the first tranche of income. That was my understanding. I wondered how the two measures interacted.

Kitty Ussher: My understanding is that this is a specific provision for those specific circumstances and that there will be no effect on the broader provisions in schedule 1. If I am advised differently, I will return to this point.
On timing, trust legislation is a complex area. The trust modernisation legislation was consulted on widely, but this omission was not picked up by the trust industry at the time. Ministers became aware of the issue at the end of last year and action will be taken as soon as possible to ensure that no beneficiary in this situation will be adversely affected.
The hon. Gentleman also mentioned age-related allowances. That is a different type of benefit. The primary focus of age-related allowances is to provide additional support for those on lower incomes. The income used to determine entitlement is the individual’s total income for the tax year from all sources of income. That focus would be disturbed if settlor-interested trust income that has a tax credit covering the income tax liability was exceptionally excluded from the total income. We feel that that would be inappropriate.

Philip Hammond: Does the Economic Secretary agree that in that example given there is effectively double taxation? There is taxation in the hands of the settlor and in the hands of the recipient. After the correction in the clause is made, does she agree that the person in receipt of the age-related allowance is effectively unique in being double taxed on that income distribution?

Kitty Ussher: The hon. Gentleman rightly makes the point that has been made by the Institute of Chartered Accountants in England and Wales. That point has been made to us as well. Our response is that this is a matter of consistency. The focus for the age-related allowance would be disturbed if settlor-interested trust income that has a tax credit covering the income tax liability was exceptionally excluded from total income. We do not agree with the view of the ICAEW that it is double taxation, but the taxation will be increased. We are happy to pursue this point with the ICAEW offline.
To clarify the point that the hon. Gentleman raised on the relationship of this provision with schedule 1, non-settlor interested income is pushed to the top of the ordering.

Question put and agreed to.

Clause 64 ordered to stand part of the Bill.

Clause 65

Income charged at dividend upper rate

Question proposed, That the clause stand part of the Bill.

David Gauke: It is a pleasure to serve under your chairmanship again, Mr. Cook.
I will discuss the clause briefly. I do not think that it will be controversial. The clause concerns the taxation of foreign dividends that are taxable only if remitted to the United Kingdom. Until 2005, they were taxed at the higher tax rate, which is currently 40 per cent. Through a drafting error in the Income Tax (Trading and Other Income) Act 2005, they were instead taxed at dividend rates so that the upper tax rate became 32.5 per cent. That applied for 2005-06, 2006-07 and 2007-08, but it is being corrected for any remittances of foreign dividends made after 6 April 2008. Will the Economic Secretary say what that drafting error has cost the Exchequer?
The error resulted from the tax law rewrite project. It is probably inevitable that some errors will be made from time to time as previous Acts are re-enacted in language that is supposedly easier to understand. However, I cannot help noticing, just from the clauses that I have looked at in the Bill, that this is the second example of an error arising as a consequence of the tax law rewrite project. Clause 46, relating to employment-related securities, is another example.
I do not take a zero tolerance approach; such errors will occur from time to time. However, I would be grateful if the Economic Secretary—if not now, at some point—gave the Committee the running total of identified drafting errors with regard to the tax law rewrite project. A year or so ago, I asked a parliamentary question on that point to the right hon. Member for Bristol, South (Dawn Primarolo), when she was Paymaster General. Nine errors had been identified and corrected in the Capital Allowances Act 2001 and 18 in the Income Tax (Earnings and Pensions) Act 2003. Four errors had been corrected in each of the Income Tax (Trading and Other Income) Act 2005 and the Income Tax Act 2007. I have also heard it suggested that the tax law rewrite project identified some errors in the existing law. That is entirely understandable. Will the Economic Secretary tell us whether that is true, and if so whether it has resulted in any broader changes in the law? Subject to those comments, we have no objection to clause 65.

Kitty Ussher: I am grateful for the hon. Gentleman’s support for the clause, which corrects a drafting error introduced by the tax law rewrite project that consolidated legislation in 2005.
To respond to the hon. Gentleman’s final point, the rewrite project, by definition, did not change any policy. I was not the Minister at that time, but I presume that if errors were found it would have been sensible to correct them. There were certainly no policy changes at that point. The error before us set the higher rate of income tax on foreign dividend income remitted to the UK by those charged on a remittance basis at 32.5 per cent. We are correcting that error and reapplying the 40 per cent. that applied until 2005. A remittance-basis user who is taxed at the basic rate will continue to have their foreign dividends taxed at 20 per cent. The clause simply restores the position to what it was before the mistake.
The hon. Gentleman asked how many errors were identified as regards the tax law rewrite project. I am happy to get the team to count again and send him a note. However, given the scale of the rewrite, finding errors is like looking for a needle in a haystack. We are pleased with the result of the project. The wider economy also feels that we have done a good job. Obviously any error is regrettable, but I ask the hon. Gentleman to consider the number of errors in the context of what has been achieved, and to acknowledge that that number is extremely small. He asked about the cost of that particular error. The yield from correcting it is around £10 million per annum, and I therefore extrapolate that that is what was lost in the intervening years. However, we are applying the clause from 2008-09 so that nobody who inadvertently benefited subsequently loses out. I thank the hon. Gentleman for his broader support.

Question put and agreed to.

Clause 65 ordered to stand part of the Bill.

Clause 66

Payments on account of income tax

Kitty Ussher: I beg to move amendment No. 144, in clause 66, page 34, line 26, leave out from ‘effect’ to ‘for’ in line 27 and insert
‘for the purpose of calculating the amount of any payments to be made under section 59A of TMA 1970 on account of liability to income tax’.
This is a minor amendment, which achieves two things. First, it clarifies that the repeal—I hope that Opposition Members are listening—of section 964(5) of the Income Tax Act 2007 takes effect for certain annual payments on account for the tax year 2008-09 and for subsequent tax years. Secondly, it replaces an incorrect reference: the clause refers to the Income and Corporation Taxes Act 1988 rather than the Taxes Management Act 1970. The amendment will ensure that the clause works as intended.

Amendment agreed to.

Clause 66, as amended, ordered to stand part of the Bill.

Clause 67 ordered to stand part of the Bill.

Clause 68

Thermal insulation of buildings

Question proposed, That the clause stand part of the Bill.

Frank Cook: You had me worried.

Justine Greening: I am always reticent to start speaking during a Committee, having once been called to speak while flattening down the back of my skirt—the experience stayed with me for some time.
As the clause is intended to encourage and incentivise businesses to take more energy-saving measures in the course of their day-to-day operations, I obviously support it and understand the rationale behind the need to include it in the Bill. We support measures taken by the Government to encourage businesses to invest in better insulation for their operations. It is good for not only businesses that reduce energy costs over time, but the environment.
We recognise that the clause intends to extend the provision of capital allowances relating to the expenditure of adding insulation to reduce the loss of heat from a building—thermal insulation. Currently, the existing provision covers expenditure on thermal insulation for existing industrial buildings. Given that the phased withdrawal of industrial buildings allowance by April 2011 is now planned, obviously the clause needs to extend provision to the initial thermal insulation of all existing buildings used for any qualifying activity other than residential property businesses.
I have only some brief comments on the clause. In the explanatory notes, the Treasury states that extending the provision of this measure will widen its environmental benefit. I understand and accept that it can be difficult for the Treasury to estimate the precise environmental impact of the sort of measures that are introduced to encourage environmental benefits. I realise that that is not easy, but want to get some idea of whether the Treasury has tried to get an understanding of the environmental benefit that it hopes to achieve from the clause.
That is important because, with limited Treasury resources and the need to keep the tax system broadly as simple as possible and avoid unnecessary complexity—Opposition Members on the Committee have certainly argued for that—if we are to understand what does and does not work, it is incumbent on the Treasury to have some understanding of the impact of such measures when it brings them forward, even if that is nothing more than a sense of the proportionate breadth of impact. That way, we will hopefully end up with up with a hypothesis on what constitutes effective fiscal measures of that sort, or we will at least put the potential impact into context.
Has the Exchequer Secretary made any assessment, however straightforward or simple, of the extent to which the clause will be used more broadly by businesses once the broader provision is available? How will the Treasury assess the effectiveness of the provision, and is there any sort of assessment on the amount of reliable spend that will be made, for example, on the thermal insulation of buildings? Do we have any sense of the amount of CO2 emissions that will be saved over time as a consequence, and is it possible to estimate the proportion of existing emissions that might fall within the scope of the clause? In short, is there any way of understanding whether this will be effective and successful?
I recognise that this expenditure will end up being classed as plant and machinery and within the 10 per cent. special rate of writing down allowances that come from allowing them to qualify as an integral feature. I have comments on integral features which we will cover later when we discuss clause 70. If the Minister could tell the Committee a little more about quantification and give an assessment of the environmental effects the Government hope to gain from the broader measure in clause 68, it would be very welcome.

Angela Eagle: I am happy to try at least to give a flavour of the effect that we think these changes will have. I shall first spend a small amount of time setting the clause in context because it is the first of a group of clauses that introduce reforms to modernise and simplify capital allowances. The hon. Lady is right to draw the Committee’s attention to the fact that it is related to the withdrawal of industrial buildings allowances, which is covered later in the Bill by clauses 81 to 84. This is a consequential provision which, confusingly, appears before those clauses. Such things often happen in legislation.
Since 1975, businesses have been able to claim plant and machinery capital allowances on thermal insulation added to existing buildings if those buildings were considered industrial for capital allowances purposes. That is because of the existence of the industrial buildings allowance, which later clauses abolish. Such expenditure would not otherwise have qualified for any plant and machinery capital allowances. These plant and machinery allowances have been available at the main rate of 25 per cent., which is reducing to 20 per cent. as part of the package. Again, the hon. Lady alluded to that in her questioning earlier. The measure does not apply to expenditure on insulating new buildings, because building regulations now require that thermal insulation at certain standards be part of any new buildings. The sector we are dealing with is the stock of other buildings that existed before the building regulations were changed.
By abolishing the industrial buildings allowance, we are extending these payments to commercial buildings, rather than just industrial buildings, which is a much wider range of potential stock of buildings than were caught under the old system. Our calculations demonstrate that that extension increases the scope of the measure by £162 million to £201 million a year. Although the allowances are 10 per cent. rather than 20 per cent., the potential pool of buildings that are affected and could take advantage of the new allowances for thermal insulation is wider. We believe that there is scope to reduce energy loss from commercial buildings by about 8.25 megatonnes.

Justine Greening: When the hon. Lady talks about 8.25 megatonnes, is she talking about a cumulative effect over time and if so to what year? Are we talking about an annual reduction?

Angela Eagle: I assume that it is cumulative. I am waiting to see whether my officials can confirm that. The hon. Lady must remember that it takes time to get insulation in place and that the savings that are made tend not to come on stream immediately. I can now confirm that it is cumulative and includes all insulations that might happen as a result of this measure.

Justine Greening: I hesitate to ask this, but cumulative by when?

Angela Eagle: Again, I assume that that is the potential for all buildings that would qualify that have not already been built and comply with existing building regulations. The hon. Lady needs to remember that the thermal insulation potential and credits for putting it in place have been in existence since the 1970s. Building regulations have consistently over time tightened up on the requirements. Those who have commercial buildings have a direct financial interest in thermally insulating their buildings because they will save money on their energy bills. I would have thought that at a time such as this there is even more interest in doing so. My assumption is that that is the potential overall saving. Businesses must decide to undertake the insulation.

Peter Bone: The Exchequer Secretary cannot say over what period this will occur because it depends on how businesses take up thermal insulation. Is it equally difficult for her to say how much the Revenue will lose each year?

Angela Eagle: It is not a question of the Revenue losing money because the idea of these tax incentives is to help to create circumstances where we can have economic growth without such a large carbon footprint and thereby make our economic growth more sustainable. I do not see it as the hon. Gentleman does in terms of losses for the Revenue.
To set the matter in context, Opposition Members must remember that current building regulations mean that new commercial buildings are required to be insulated. We have had thermal insulation credits to encourage people to undertake behaviour that will reduce their own operating costs. There has been an extra incentive since the 1970s for some buildings. We are now spreading that to commercial buildings. It is not possible for me to stand in Committee and say how many buildings would qualify for the insulation because we have not had a Domesday survey of commercial buildings recently.
The hon. Member for Putney recognised when she asked her questions that it is not easy to come up with answers. I have done my best to give her a ballpark figure of what we think the savings will be. If she is going to say that that is not acceptable, when she spent her entire time when asking the question quite reasonably saying that it was very difficult to make those kinds of estimates, I do not know where that gets us.

Justine Greening: The only reason that I am pressing the Exchequer Secretary is that I was quite pleased to hear that some quantifiable assessment had been made. Obviously, it is meaningless if we do not understand what 8.5 megatonnes relates to. Regulatory impact assessments done by the Government often spread over 70 years. There is a world of difference between 8.5 megatonnes being achieved cumulatively over that time frame and it being achieved by 2020.
Given that the Climate Change Bill is before the House, I want to understand how measures such as this clause will form part of the overall effort to reduce emissions over the near-term years, which we all support. I am pressing the Exchequer Secretary to give us a little more information on that. She has given us a tantalising bit, but it is not meaningful if we do not know the time frame.

Angela Eagle: I am doing my best to enlighten the Committee by making these difficult assessments. I can give some information on the costings, which the hon. Member for Wellingborough asked about. The cost is zero this year because we have to put the system in place. We expect it to be £5 million next year, £10 million the year after and £15 million thereafter to 2010-11. Hon. Members have to remember that that is tax at the margin, not the overall amount of money that will be spent on insulation—it is a tax credit and it is marginal.
The 8.6 megatonnes figure, which I gave the hon. Lady earlier, is the annual loss, we think, per year from commercial buildings that are not insulated. If all buildings were insulated that amount would be saved. The hon. Lady must remember that a lot of buildings are insulated and that new ones are required to be. We estimate that that amount would be saved if all commercial buildings instantly took account of the new tax credit available to them and did what they should have been doing anyway, which hopefully they will do because it saves money on their energy bills, regardless of whether the tax credit exists.

Jeremy Browne: I am grateful for that clarification from the Minister. If that is the annual potential saving, will she give us an indication of the Treasury’s predicted cumulative figure between now and 2020?

Angela Eagle: The hon. Gentleman can do his own sums—8.5 by 12.

Justine Greening: There is, perhaps, a more pertinent question. The Minister’s figures are helpful to understand that that is the, if you like, global amount of emissions that we think that the policy could address. Has the Treasury made an assessment as to how much of what we could see saved will be saved over time?

Angela Eagle: To be honest, that depends on the behaviour of individuals who can apply for the tax credits—perhaps all of them will, or all of them will not.

Jeremy Browne: The calculation must have been done. The Treasury has worked out how much the provision will cost in tax, so it must have done the equivalent calculation to see how much will be saved. That figure must exist.

Angela Eagle: I have given the Committee the estimate of what the measures will cost annually. I have given the Committee the figures on the potential savings from those commercial buildings that remain uninsulated. I have also given the Committee the figure for the size of market that we suspect will be generated annually, which is £201 million. Short of being able to give the Committee individual information about what Mr. Bloggs and Mr. Smith, who own commercial buildings, will do, I do not know what else I can say. I have tried to be helpful, but I do not think that I can give any more figures.

Mark Field: Will the Minister give way?

Angela Eagle: If the hon. Gentleman asks me for another figure, I am not sure that I will be able to assist.

Mark Field: Perish the thought that I would ask for another figure. Does the Minister accept that the cascading figures are almost meaningless, because part and parcel of the proposal is a mechanism for the allowances that will allow and, indeed, encourage people to change their behaviour? Obviously, we do not know how long a particular building’s life cycle is likely to be; it may already be 15 years old when it qualifies for the allowance and be demolished in a few years in any event. Above all, the policy shows the inherent contradiction in the Government’s approach to motor cars. The Government say that they want to encourage different behaviour, which may have a cost in relation to allowances. However, people who own motor cars for six or seven years will be taxed under the current arrangements, irrespective of any change that they can possibly make to their behaviour. It is that inherent contradiction that we find so concerning, not so much in this regard but in regard to general policies to encourage behaviour on environmental grounds.

Angela Eagle: I am sorry that I gave way to the hon. Gentleman now. Mr. Cook, I am sure that you will not let me start talking about vehicle taxation in a clause on thermal insulation—unless we are going to talk about thermally insulating our cars.
The clause preserves the availability of the allowances for industrial buildings, but at a more appropriate rate, and it extends relief to commercial buildings, which simplifies the tax system by removing previous distinctions. It will help to retain and extend the incentive for businesses to improve the energy efficiency of their existing buildings, while complementing the approach taken to integral features, which I know the hon. Member for Putney will bring up at the appropriate time in discussing another clause.

Justine Greening: I must admit that when I set out a few questions for the Exchequer Secretary, I did not expect to get into such a discussion. I am pleased that the Treasury has tried to make an estimate, but am disappointed that we were not able to get slightly more detail. Even within the response that we got, the initial figure from the Exchequer Secretary of 8.25 megatonnes became 8.6 megatonnes. It also went from being a cumulative figure to an annual figure, and we never did get to what the impact of the policy will be. Surely if we are going to bear down on carbon emissions, we must have some understanding of what an appropriate mix of policies will be in each area of life. If we are talking about office and commercial buildings, surely we need to know whether this particular fiscal measure will be the key one, the one that the Treasury expects will address the issue, or whether it is a limited measure and we need to look at other policies if we are going to achieve the level of reduction in CO2 emissions that we want in that area of activity.

Jeremy Browne: I, too, observed the confusion in the Exchequer Secretary’s speech, including the different figures and the inability to distinguish between cumulative and annual savings. Does the hon. Member for Putney share my concern that that is indicative of a wider approach by the Treasury towards environmental taxation, which is that it seems to be willing to sing the environmental song without understanding the words?

Justine Greening: The hon. Gentleman makes a fair point. I raised the issue because we need to be successful in this area. Therefore, understanding whether the various measures that have been taken across a range of areas will add up to success is critical.

Angela Eagle: Is the hon. Lady saying that she is against the changes, and that she thinks that they will have a detrimental effect on our carbon footprint?

Justine Greening: Obviously, I am not saying that. In seeking reasonably to understand how effective the changes will be, the responsible thing for me to do as an Opposition spokesman is to try to understand what the Treasury wants to achieve through the policy. Obviously, we are not making progress. We appreciate why the measures are being brought in; it is just disappointing that the Treasury does not have a clear idea of how successful they will be.

Question put and agreed to.

Clause 68 ordered to stand part of the Bill.

Clause 69

Expenditure on required fire precautions

Question proposed, That the clause stand part of the Bill.

Justine Greening: The clause repeals section 29 of the Capital Allowances Act 2001, which gave plant and machinery allowances to businesses that incurred expenditure in undertaking required fire precautions as a result of being served with a prohibition notice by a fire authority. I understand that expenditure for such purposes would include structural works and alterations to buildings, for example fire extinguishers, signage, alarms and sprinkler systems—critical spend for ensuring that workplaces are safe for those who work in them. However, as I am sure the Exchequer Secretary will mention, ironically, the relief was available only if a notice had been served as a result of non-compliance under a self-assessment regime. Those businesses that incurred spend responsibly in the area, because they were taking fire precautions, were not able to obtain relief, whereas those that had not bothered but were caught and handed a non-compliance notice, were given relief. Ironically, preferential tax treatment was given to people for bad behaviour. The repeal in the clause is therefore understandable.
My main query for the Minister is about the extent to which businesses will be captured by the measure. For example, how many non-compliance notices have been handed out by fire authorities over the past two or three years? Is this a minor tidying-up measure which the Government expect will have relatively little impact? Is it more about equity, or do the Government expect it to have a broader impact in sending out a message to businesses that non-compliance with these critical areas of health and safety will not be tolerated and certainly will not be given tax relief?

Angela Eagle: As the hon. Lady rightly points out, the clause repeals a section of the Capital Allowances Act which, since 1971, provided relief to capital expenditure on alterations to existing buildings required by a fire authority notice. Building regulations again have intervened and required the necessary fire safety precautions since 1976. The relief has served its purpose and is now little used. The hon. Lady should remember that most expenditure on fire prevention is deductible as revenue expenditure, or qualifies for capital allowances under first principles anyway.
The redundant nature of the requirement became even more clear in October 2006 when, instead of a certificate to improve, prohibition notices were introduced. I am told that approximately 50 prohibition notices are handed out a year. The hon. Lady rightly saw the irony in a system which gave a tax relief for those who put people’s lives at risk in order to put right the problem in the building, but did not encourage people who did it voluntarily and did not put people’s lives at risk to take that action. That is why the section is being repealed.

Question put and agreed to.

Clause 69 ordered to stand part of the Bill.

Clause 70

Integral features

Question proposed, That the clause stand part of the Bill.

Justine Greening: The clause introduces one of the most fundamental changes to the capital allowances regime in this year’s Bill, because it provides for a new classification of integral features of a building or a structure, expenditure on the provision or replacement of which will qualify for phantom machinery writing-down allowances at a rate of 20 per cent. through the insertion of new sections 33A and 33B into the Capital Allowances Act 2001.
The principle of creating a new category of capital allowances for integral features of buildings has been broadly welcomed by business, mainly because that was the approach that seemed to be favoured by the majority of businesses at the earlier consultation that the Treasury undertook. The use of a simple list of qualifying features rather than laying out a definition should, in theory, ensure simplicity, although I will come on to why it will not quite work like that in practice. From an environmental point of view, including electrical and water systems should help to encourage the use of green technology for those systems which previously would not have qualified for allowances.
However, the breadth of assets captured by the new category of integral features is so broad that, unless we get further guidance from the Treasury, it is in danger of increasing rather than decreasing complexity. There seems to be a risk that it will capture many more classes of asset than is perhaps intended, although we will hopefully get to hear from the Minister what the Treasury’s intention is in a little more detail later. Obviously the measure will spread the tax relief over much longer periods, compared with the 20 per cent. pool for plant and machinery.
I realise that the approach chosen by the Government to define an integral feature is vital and there were broadly two choices of how to do that. We could have a general definition, by which criteria were established to see whether any given spend met the criteria and therefore qualified as an integral feature. That might be related to purpose or it could be trade specific. Such an approach might have had the advantage of being flexible enough to cope with the wide variety of situations that businesses may find themselves in with regard to spend on what might be classed as integral features, but the downside is that it leaves more uncertainty. Presumably, we would then have to rely on legal cases to establish where HMRC should draw lines in practice.
The other route is to be more prescriptive and simply to come up with a list of what is in and what is out. I accept that the Government’s preference for a definition of which assets should fall within the new 10 per cent. pool was for the second approach: a simple list rather than a purposive definition. Having read the consultation response from the Government in the technical note of December 2007, I understand that the majority of the respondents found favour with the second approach. Even so, some questions remain as to how it will work in practice and how to ensure that it works as intended. I should therefore like to take the opportunity to ask the Minister to clear up some of the uncertainty that business still has regarding the working of the clause in practice.
Under proposed new section 33A(5) an integral feature is defined as:
“(a) an electrical system (including a lighting system),
(b) a cold water system,
(c) a space or water heating system, a powered system of ventilation, air cooling or air purification, and any floor or ceiling comprised in such a system,
(d) a lift, an escalator or a moving walkway,
(e) external solar shading.”
A further item was included in the original pre-legislative list—active façade systems—in many cases known as windows. Obviously for tax purposes, things such as the internal and external aspects of the fitting are never quite so straightforward. I understand that active façades will qualify, but perhaps the Minister can confirm that. In particular, was there a reason why HMRC had them in the original list but then took them out? Although active façades will be able to be part of the list approach, tax inspectors on the ground may take a more restrictive view of what is included and seek to exclude them. It is important to get some clarity from the Minister on that. Later, I will come on to why having general guidance from the Treasury on that is important.
The clause contained a power to remove plant or machinery from the list, or to add assets that would not otherwise be plant or machinery to it. The power did not, however, give the Government power to add plant or machinery or remove assets that would not otherwise be plant or machinery. I understand why the Minister has taken this approach and I accept that it gives flexibility to add greener assets along similar lines to those in the list.
For the definition to work effectively, business must know how HMRC will interpret the rules of the allowance. The technical note in December, “Business tax reform: capital allowance changes”, stated on page 47 that
“the government acknowledges the need of business for early sight of guidance on how HMRC will interpret the legislation governing the integral features allowance.”
That was to give certainty to business in understanding how the allowance would work in practice. My understanding is that we have not yet had that guidance. Will the Exchequer Secretary tell us when we can expect to see the guidance and when business can expect to get a clearer idea of how the clause will work in practice?
The transfer of existing buildings will potentially be complicated for businesses because different sets of rules might have to be followed depending on whether the transfer is between parties that are connected or unconnected and whether there are intra-transfers within chargeable gains groups. Parties concerned in the transfer of property will have to consider carefully whether it was owned prior to or after April 2008. That could be complicated because the parties concerned will have to look carefully at matters such as elections and disposal values. They will need to understand the different approaches and determine which code they need to follow.
I want to follow up the issues of replacement and repairs with the Exchequer Secretary. The Treasury appears to be trying to define the 50 per cent. equals replacement rule in terms of spend, but there is ambiguity in that rule and perhaps some unfairness. Can she clarify the logic behind the replacement of integral features approach, so that we can better understand it?
An interesting article in The Tax Journal in April 2008 gave the example of a business that owned three floors of a building and totally replaced the wiring and fittings on one floor. In theory, that would not meet the 50 per cent. replacement rule. However, that floor received 100 per cent. replacement. Would HMRC approach that example as not meeting the 50 per cent. replacement rule, as I think it would, or are there difficulties because it is a total replacement of one part of the building? There is an additional issue that repairing one aspect of something could be so expensive that it would be classed as a replacement, whereas to all intents and purposes, it was a repair.
With all of these problems there is the obvious issue of complexity. When carrying out what they think are repairs, companies must estimate the costs from the outset because they could end up doing what is classed for tax purposes as replacing integral features. It is important, therefore, that the Exchequer Secretary covers that in slightly more detail than we have had in the explanatory notes.
A further point that I want to follow up related to the specificity of the list approach and possible unintended consequences of the inclusion of cold water and electrical systems in the classification of integral features of a building or structure. I understand that there have been concerns within the water and electricity industries that the inclusion of those items could end up including the water processing and supply systems of the water industry or the generating and supply systems of an electricity undertaking. The explanatory notes state that that should not be the case and that the list has
“no particular or unique bearing on these businesses’ tax treatment, compared with other businesses.”
Even so, it would be helpful if the Exchequer Secretary could make it clear that those industries will not be inadvertently captured by the inclusion of those items on the simple list. We understand why they are there, but will she at least confirm that the interpretation will be as we expect and not any wider? Again, if we had had guidance from the Treasury, as was promised, it would have been easier to answer those questions already, and that shows why having that guidance as soon as possible is vital.
I understand that the issues of the breadth of interpretation of the simple list item will be of broader concern to other businesses, and although I have mentioned particular issues raised by the water and electricity industries, other cases might also come out in the fullness of time, after the Bill has been enacted. Therefore, perhaps the Exchequer Secretary will confirm that concerns about the lack of guidance have been raised with the Treasury by the CBI on behalf of its members. I am concerned that the explanatory notes, although they deal with that point, ultimately do not fully address the concerns of business and that there seems to be continued uncertainty. Therefore, it would be helpful if she could provide some clarification on those matters.
Overall, we understand that the Government took that approach because it was the one favoured by business at the time of the original consultation. I question whether business would still have been in favour of that approach had they been able to see the Bill as we do today, but more clarification from the Exchequer Secretary might address some of the concerns that businesses currently have about that area. We might nevertheless get to that simpler situation with regard to the treatment of capital allowances that, as she has said already this morning, the Government intended to achieve when they made these changes.

Angela Eagle: The clause introduces a new capital allowance classification of integral features of a building or structure. It is part of a wider package of reforms to business taxation that was announced in the Budget 2007 and designed to promote investment and growth through reduced administrative burdens and complexity. I am glad that the hon. Lady has made a point of saying that simplicity is also important in maintaining both reforms of that kind and the fairness of the tax system.
The reforms include the 2 per cent. cut in the main rate of corporation tax from 30 to 28 per cent. and a simplified capital allowances system, with two main rates of plant and machinery allowances: the 10 per cent. rate and 20 per cent. rate. The clause puts into effect the list of integral features, as the hon. Lady has said.
Against that background and as part of those reforms, the Government announced their intention to introduce a separate capital allowances classification of assets that are commonly integral features of a building or structure so that expenditure on those assets can be included in the new 10 per cent. pool. The Government decided to introduce the new classification because over the years—this is an important point that relates to what the hon. Lady said about simplicity—the boundary between plant and machinery and commercial buildings has been an area of considerable doubt and uncertainty in tax law. The current law fails to reflect commercial reality, in that, over time, assets commonly regarded as integral parts of modern buildings, such as central heating and lifts, have come to attract plant and machinery capital allowances at the main rate, which, although it is reduced—

Peter Bone: Will the Minister give way?

Angela Eagle: I will give way when I have finished my sentence—although the rate is reduced from 25 per cent. to 20 per cent. by clause 77, it does not generally reflect the average rate of economic depreciation. With the full stop approaching rapidly, I give way to the hon. Gentleman.

Peter Bone: I apologise for interrupting the Minister mid-sentence. Where a company has had to put in a disabled lift because of Government legislation, how would that have been treated in the past? What rate would it have attracted? I assume that it will attract a 10 per cent. rate in the future. What does it currently attract?

Angela Eagle: I will deal with that point, if I can, in due course. I was talking about economic depreciation and how the new 10 per cent. rate is more easily aligned with that. Our purpose in introducing the new classification is to ensure that certain assets, commonly standard in modern buildings, should be eligible only for the 10 per cent. “special rate” of writing-down allowance and should not be classified as plant and machinery. The rationale is that a 10 per cent. rate is more appropriate than 20 per cent. on selected assets, because they can have longer average economic lives than plant and machinery do generally.

Philip Hammond: Has the Treasury surveyed what the average economic depreciation of plant and machinery assets is across the board? I have seen other organisations’ estimates that suggest that the average rate of depreciation in financial accounts is something like 11.9 per cent. Is the Treasury’s 10 per cent. based on a different analysis or has it just taken 11.9 and sliced a bit off for good measure?

Frank Cook: Maria Eagle.

Angela Eagle: Angela, Mr. Cook. You are not the first person to make that error and I am convinced that you will not be the last.
The Treasury does not just take a number and slice bits off in that way. It does its own research on these matters. There have been efforts to establish, not only in the accounting professions but in the Treasury itself, precisely what the rate of economic depreciation on such assets would be. Her Majesty’s Revenue and Customs looked at 190 large UK groups and found average depreciation rates of 17 to 19 per cent. on those assets.

Philip Hammond: The Minister will anticipate the next intervention. If the average depreciation rate is 17 to 19 per cent. and, as she has told us, the purpose of bringing it down from 25 to 10 per cent. is to bring it more into line with economic rates of depreciation, how does her Department’s survey justify the figure that she has chosen?

Angela Eagle: The survey was about all assets and it did not look at the difference between short and long-life assets. I am sure that if the hon. Gentleman stopped and thought about it, he would have known what I was going to say.
I shall respond to the hon. Member for Putney, but I have been sidetracked down highways and byways. I want to answer the hon. Member for Wellingborough’s question about disabled lifts—the rate was 25 per cent. before April 2008 and it is 10 per cent now.
To go back to our purpose in introducing the new classification, the rationale for the change is that for long-life assets the 10 per cent. rate is more appropriate than a 20 per cent. rate, because long-life assets last longer and one can get more services out of them before they depreciate. The clause lists the selected integral feature assets, which, as the hon. Lady said, include electrical systems, hot and cold water systems, heating, air conditioning systems, lifts, escalators and moving walkways. The list also contains a building feature that is environmentally beneficial, which is external solar shading. Such expenditure on the fabric or shell of the building itself would not normally qualify for any plant and machinery capital allowances, but its inclusion on the list means that it will attract allowances of 10 per cent. a year.
I want to spend a little time dealing with the hon. Lady’s questions. The 2007 consultation document explained why we were not attracted to the so-called purposive approach to the new classification of integral features. I detected from her contribution that she was of that opinion. She was certainly very understanding of the approach.

Justine Greening: As ever, my party wants to listen to businesses and work with them to achieve solutions that work for them. It was therefore encouraging that the Treasury adopted the approach that businesses said they favoured at the initial stage. My concerns are about the implementation of that approach that appears in the Bill. We must resolve these issues so that the measure can work as businesses had intended when they said that they felt this was the better route to take.

Angela Eagle: I am grateful to the hon. Lady for saying that she holds a similar opinion to the Government on this issue. I welcome her view that simplicity is an important effect that we are trying to achieve. We believe that the measure should simplify the current systems. The definitions of electrical systems have not changed and the trade-specific qualifications are no longer there, which is a major simplification of the system.
The hon. Lady asked about guidance and I can tell her that it will be produced for Royal Assent. Once the Bill has become law, HMRC will ensure that there is guidance on the interpretation of the new capital allowances that she talked about so that companies can take advantage of them.

Justine Greening: May I press the Exchequer Secretary to see whether there is any chance of getting the guidance earlier? The sooner business can look at the guidance and understand the impact in practice, the better. I appreciate that Royal Assent is a calendar point when everything can be issued at the same time, but that will not give business much time to look at this matter. I encourage her to look at whether it is possible for the Treasury to bring forward guidance earlier.

Angela Eagle: The Treasury will have to bring forward guidance when it can ensure that it is appropriate in detail and robust enough to stand up to scrutiny. There is no point in producing guidance quickly if much of it is wrong. There is always a balance. I have said to the hon. Lady that we intend to produce the guidance for Royal Assent. If it came to my attention that the guidance was in existence and was ready and waiting to go, it would be in everybody’s interests to make it available as soon as possible. However, it is important that we ensure that it is as robust as possible before it is issued so that confusion does not result.
The hon. Lady asked about the removal of active façades from the list. She was quite right to point out that that means windows in ordinary language. She will know, as will anybody who has lived in a leasehold property, that there is the outside of a window and the inside of a window. For the purposes of her question, that is an important distinction, believe it or not. She asked why active façades are being excluded from the list. It is already accepted that the external skin of the active façade—I will not say window—is not eligible. However, the internal skin can be eligible because in effect it creates a duct within which the cooling or heating air circulates. In other words, the relevant parts of these systems, if they are ducts within which cooling or heating air circulates, already qualify as integral features by virtue of being part of the cooling or heating systems of the building. So the answer is that if air is circulating and it is part of a cooling or heating system—the windows internally count as integral parts—the outsides are not but the insides can be.
Justine Greeningrose—

Angela Eagle: I am not sure what further light I can cast on this issue, but I am happy to try.

Justine Greening: There is further light. Will this be the kind of clarification that businesses can expect to see in the guidance notes?

Angela Eagle: Well, they can see it in the proceedings of this Committee if they care to look. Clearly the guidance will also deal with issues such as that.
The hon. Lady also asked about transfers. We recognise that it is common for property and other companies to transfer properties intra-group. In those circumstances it would be unfair to require the company acquiring the property on or after April 2008 to reallocate old expenditure to the new 10 per cent. special rate pool. So we have provided in clause 79 and schedule 26 that in these circumstances the parties may elect that their old integral features expenditure be allocated to the buyer’s main rate pool. In the case of unconnected persons, the existing section 198 rules which enable parties to agree the value of fixtures on transfer already require the parties to identify amounts and actual assets covered. So allocating the expenditure attributed to some of these identified assets to the new 10 per cent. pool should not pose too much of an additional burden.
The hon. Lady also asked about the replacement rule. She used the example of the electrical system being replaced in three floors of a building and asked whether that would be replacement or repair. If the company owned three floors and replaced the electrical system for one floor—those of us who are whiz at mathematics can work out that that is a third rather than 50 per cent.—it would be classed as a repair, not a replacement. She also mentioned some of the worries that have been expressed by the water and electricity industries about the classification of cold water systems and so on in the list and wondered whether that would apply to bigger utility plants.
I am glad to take this opportunity to clarify that the inclusion of cold water and electrical systems of a building or structure in the new integral features classification does not mean that the disparate assets that comprise a water processing and supply system of the water industry or the electrical systems of an electricity undertaking would be caught by the new definition. The classification applies to systems for the use and consumption of water and electricity, not for their production and distribution. I hope that the hon. Lady will consider that clear enough.
To come back to the guidance not being published yet, companies will not have to submit returns including their integral features calculations for up to 12 months. Long before that time, HMRC will have provided full guidance on the new classifications in order for the transfer from the old to the new system to proceed with as little disruption as possible. I hope that with those clarifications, the clause can stand part of the Bill.

Justine Greening: I am grateful to the Minister for providing some clarity. Obviously the sooner we can get the guidance the better. Particularly with respect to some of the concerns that businesses have raised since the original consultation, I urge her to work closely with businesses to address any remaining concerns, especially on some of the issues I have raised today. Although they may be clear to Ministers, we need to make sure that they are clear to tax inspectors who are working with businesses day to day.

Question put and agreed to.

Clause 70 ordered to stand part of the Bill.

Clause 71

Annual investment allowance

Question proposed, That the clause stand part of the Bill.

Angela Eagle: The clause introduces the schedule that introduces the new annual investment allowance. That is part of a wide-ranging package of business tax reforms that the Government announced in the 2007 Budget, the main objective of which is to promote investment and growth, not only through a lower corporation tax rate on a broader base, but by refocusing the tax system for small businesses by means of generous and better-targeted incentives for investment. The new annual investment allowance will provide that generous new incentive.
The annual investment allowance will provide, in effect, an annual 100 per cent. allowance for the first £50,000 of investment in plant or machinery—other than cars—to businesses, regardless of their size. It is also a major simplification for the 95 per cent. of businesses that invest less than £50,000 a year in plant and machinery.
The Government consulted extensively about the design and technical detail of the annual investment allowance through the publication of formal consultation documents in July and December 2007. Respondents to the consultation generally welcomed the proposed annual investment allowance and agreed that it would be of particular benefit to smaller businesses. In its documentation, the Conservative party proposed to abolish the annual investment allowance, so it will be interesting to see whether Conservative Members vote against the clause.

Question put and agreed to.

Clause 71 ordered to stand part of the Bill.

Schedule 24

Annual investment allowance

Philip Hammond: I beg to move amendment No. 200, in schedule 24, page 288, line 33, leave out from ‘partnership’ to ‘or’.

Frank Cook: With this it will be convenient to discuss the following: Amendment No. 201, in schedule 24, page 288, line 34, at end insert ‘; or
(d) a trustee’.
Government amendment No. 146
Amendment No. 202, in schedule 24, page 289, leave out lines 41 and 42.
Amendment No. 203, in schedule 24, page 290, line 14, at end insert—
‘(7A) Where AIA qualifying expenditure incurred in a chargeable period is less than the maximum allowances, the unused allowance may be carried forward to relieve future qualifying expenditure in a subsequent chargeable period or carried back to relieve unrelieved qualifying expenditure in the previous chargeable period.’.
Government amendment No. 147

Philip Hammond: Schedule 24 deals with the substance of the annual investment allowance changes. While I shall try not to rise to the provocation of the Exchequer Secretary’s previous remarks, I will say that the Opposition’s proposals are to scrap the annual investment allowance and the increases in the small companies corporation tax rate, which the Government are imposing. Since it is not within our power to table amendments to the Bill that would have that effect, as the Committee will understand, it would be entirely inappropriate to scrap the allowance without being able to do the other side of the equation and maintain the 20 per cent. rate of small companies corporation tax.

Jeremy Browne: I appreciate the limitation that the procedures of the House put upon us, but will the hon. Gentleman confirm for the avoidance of doubt that it remains the Conservative party’s policy to have exactly the same overall tax burden as the Labour Government?

Philip Hammond: I think that we are going slightly wide of the point, but as the hon. Gentleman knows, we have made a commitment to match the Government’s spending plans for the three years of the comprehensive spending review period. When that commitment was made, it looked as though that would only bind an incoming Government for the first year, 2010-11, but by the way they are going, one wonders whether the change might occur rather earlier. However, I am sure that you would not wish me to explore that line of thinking in any detail this morning, Mr. Cook.
As the Exchequer Secretary said, schedule 24 introduces the annual investment allowance that was announced in the 2007 Budget and a capped, 100 per cent. first year writing-down allowance of capital expenditure up to a limit of £50,000. Let us focus on what the provision will replace. It will replace the first year allowances for small companies that have been available in recent years. It also has to compensate small companies for the loss of industrial buildings allowance and agricultural buildings allowances and the drop in the standard writing-down allowance from 25 per cent. to 20 per cent., or 10 per cent. in the case of integral features, as we have just debated. It is also supposed to compensate small companies for the staged increase in the small companies corporation tax rate.
It is true to say that the overall package of capital allowance reforms and corporation tax changes is neutral, broadly, but it would not be true to say that the impact of these measures on small business was neutral. The cuts in capital allowances for large companies are offset by cuts in the main rate of corporation tax, but overall this package of corporate tax changes raises the taxes on small companies, which will see their allowances cut and the rate of corporation tax they pay increase. Of course, the annual investment allowance will also be introduced; I will come to that in a moment.
The average gain for a UK business from the introduction of the AIA in 2008 will be somewhere between £60 and £70. That is calculated by taking the Treasury’s annual cost of the AIA—£920 million—and dividing it by the Treasury’s estimate of the number of businesses in operation. In contrast, the average cost of additional corporation tax for small companies as a result of the removal of the small companies rate will be will be approximately £1,000 extra.
All the amendments to the schedule have been grouped together. Therefore, with your permission, Mr. Cook, I intend to address not only the amendments, but one or two other points that would relate to the schedule in a stand part debate, as the amendments cover quite a wide ranging area.
Government amendments Nos. 146 and 147 correct a defect in the drafting. I am glad that that was spotted before the Bill got through the House. This is a matter of parliamentary procedure. We are happy with those amendments and agree that they are sensible and should not have any unintended consequences.
On amendments Nos. 200 and 201, the annual investment allowance to be introduced under schedule 24 is available only to companies, sole traders and partnerships exclusively between individuals. That treatment discriminates against mixed partnerships, which are formed between companies and individuals. It also discriminates against any form of business carried on by a trustee, whether as a partner in a partnership—I shall mention in a minute how that might arise—or where a trustee or trustees are carrying on business in their own right as trustees.
Partnerships between companies and individuals are common, particularly in the agricultural sector and they are not unknown in the property sector. Partnerships between companies are a common form of joint venture structure. Trustees, particularly trustees of farmland, may wish to carry on a trade or enter into partnerships to carry on such a trade. There is also a possibility, where a partner in a partnership of individuals dies and a settlement arises, that the trustees may wish to continue trading the partnership interest on behalf of the settlement. In such circumstances, I understand that the whole partnership would be denied annual investment allowance, because one of the partners had died and that partnership interest had passed to a settlement. That outcome seems inequitable. The Government have not explained why it is necessary to have such an unfair, distortive restriction. The assumption in the industry is that they must fear some kind of avoidance or abuse. In our view, discriminatory action against certain structures of business is not justified unless the Government can show a specific concern about a likely area of abuse.
The Exchequer Secretary will be aware that the Government have a stated policy of neutrality in respect of different types of business structure and of fairness between taxpayers who are in similar economic situations, regardless of their legal structure. The schedule is quite at odds with that stated objective in the way that it discriminates against mixed partnerships and trustees engaging in a trade. The amendment would delete the restriction on an eligible partnership so that all partnerships become eligible for the annual investment allowance rather than those partnerships being excluded that are formed otherwise than as partnerships of individuals. Amendment No. 201 includes an explicit provision that would allow a trustee or trustees to qualify for annual investment allowance.
Over the next few provisions of the Bill, the Committee is being invited to approve a wholesale reform of the capital allowances regime, not just a minor tinkering. To pre-empt the Exchequer Secretary’s response to the amendments, I say that in these circumstances, we do not think the mere fact that something has or has not been allowed in the past is sufficient justification for continuing with clearly inequitable treatment. In the context of a wholesale reform of the capital allowances regime, if any such unequal treatment is to continue, it must be justified on a case-by-case basis on the grounds of serious risk to the Exchequer of avoidance or abuse. I look forward to hearing the specific justification for the exclusion of mixed partnerships and trustees.
Amendment No. 202 would delete the requirement for the taxpayer to own the relevant plant and machinery at some point in the chargeable period. On the face of it, that may seem a rather odd amendment, but there is already a condition that the taxpayer must have incurred the relevant expenditure on the asset during the chargeable period. It is unnecessary and potentially inequitable to require him also to have owned the asset during the chargeable period. The first condition that he must have incurred the expenditure is sufficient to deal with the issue. Why does the Exchequer Secretary consider it necessary to have the supplementary condition that he has owned the asset during the period?
It is not uncommon for expenditure on plant and machinery to be incurred before the person incurring the expenditure has ownership. For example, where special-purpose machinery is being constructed, such as the building of a customised production line, payments on account will typically be required while the process of design, development and manufacture is underway. The expenditure will perhaps be incurred many months before the equipment is transferred to the ownership of the taxpayer. It seems irrational not to allow that expenditure when it is incurred on the basis that ownership has not been acquired at that point. Again, if the Exchequer Secretary has some significant anti-avoidance concern that causes her to make this restriction, we would be very interested to hear it. I hope that she will acknowledge that something will have to be done to ensure that staged payments on the construction of special-purpose plant and machinery, for example, are not caught in the way that I have suggested.
Amendment No. 203 deals with the transfer of annual investment allowance forwards or backwards. Under the schedule, the annual investment allowance can be carried neither forwards nor backwards. For medium-sized businesses in particular, which may invest £50,000 a year on average over a period of time, there is a risk that the lack of a carry-forward or carry-back provision will lead to tax-driven behaviour, which in turn will lead to sub-optimal outcomes in economic efficiency. That would be bad for the individual business and for the economy.
My point is that businesses will be tempted to plan their capital spending on the basis not of the economic requirements of the business or the economically most appropriate point at which to replace capital assets, but the availability of the allowance in-year. There will be a strong incentive to spread capital expenditure, which in some cases will mean delaying capital expenditure. That does not make sense for anyone, if the equipment in question needs to be replaced or new equipment needs to be purchased to increase business capacity. Perhaps that is not likely at the moment, but we live in hope that we may come to a point in the cycle where capacity is under pressure.
If the allowance were able to be carried forward, a company might be inclined to invest larger sums in new plant and equipment, knowing that it could apply some of that expenditure to first-year allowance in the second year or subsequent years. Clearly, the attractiveness of rolling expenditure forward to use a future year’s annual allowance decreases sharply beyond the first or second subsequent year, as writing-down allowances would have to be forgone. However, there is a view that there should be the ability to roll expenditure forward, and to some extent backwards, to take advantage of unused annual investment allowance. The amendment proposes an unlimited ability to roll the allowance forward, and a one-year limited ability to roll it backwards. If the Government were minded to accept the proposal in principle, further drafting would be necessary to ensure that expenditure was not relieved twice. Just to be clear about that, we envisage that writing-down allowance would be denied where capital expenditure was treated in that way, or alternatively that it would be the written-down value that was relieved in the later year. We certainly do not suggest a double tax allowance. I would be interested to hear the Exchequer Secretary’s reasons for the non-inclusion of an ability to carry forward or backwards the allowances.
As I said earlier, the schedule sets how the annual investment allowance will work, and individual businesses will have to look at that and see to what extent it will compensate them for the additional costs that they will face from the abolition of industrial buildings allowances and agricultural buildings allowances, and from the higher rates of corporation tax imposed on small companies. As ever with this Government, even sensible measures are dragged into disrepute by being implemented by stealth. If the generosity of capital allowances is being reduced to fund a reduction in the mainstream rate of corporation tax, why not say so, rather than pretending that the introduction of annual investment allowances is some kind of bonus for smaller companies that have, of course, not seen any reduction in their corporation tax rate? In the past few years, those companies have suffered an increase in that rate, unprecedented in the developed world, when the trend among all our competitors is to reduce corporate tax rates to stay competitive in the face of increasing global competition from the developing economies, particularly in Asia. There will be a significant distributional impact on different types of businesses. Those with regular eligible capital expenditure will benefit from the annual investment allowance, whereas those without such qualifying expenditure will merely suffer the impact of the abolition of industrial buildings allowances and agricultural buildings allowances, and the increase in the corporation tax rate for smaller companies.
Apart from the issues that I raised regarding mixed partnerships, the lack of carry-back and carry-forward and the unnecessary restriction on ownership of an asset, there are a couple of other points that I would like to raise with the Exchequer Secretary. There is no index-linking provision in respect of the £50,000 cap on the AIA. New section 51A enables the Treasury to amend that cap, but there is no restriction to ensure that that power is used only to increase the limit in line with inflation. Mr. Cook, the Financial Secretary has written to your co-Chairman, Sir Nicholas, about how the Treasury intends to use powers where draft statutory instruments have not yet been published, but there is no clue in that letter as to how the Treasury intends to use this particular power. It is possible that it could use the power under new section 51A to decrease that limit. We have to assume that that is not the Treasury’s intention. Can the Minister confirm that the Government’s intention, with respect to the power under new section 51A, is simply to be able to increase the limit in due course? I accept that it might not make sense to index it precisely year by year, but the intention is to increase the limit periodically, so that its real value is broadly maintained.
New section 51B introduces a restriction on the availability of the allowance for groups of companies under common control. New section 51A does the same for other companies under common control. In both cases, the restrictions apply where companies are controlled by the same person and the companies are related to one another—two separate criteria have to be satisfied. New section 51G defines “related” and provides that two companies are related if they either carry out similar activities or share premises. The similar activities test is clearly required to avoid artificial fragmentation of businesses—we do not have any argument with that. However, the shared premises test potentially gives rise to a number of problems. The first is that it is not clear what the term “carry on” means in new subsection (5), which states:
“The shared premises condition is met...if...the companies carry on qualifying activities from the same premises.”
I shall use a hypothetical example to illustrate the concern. I hope that the Minister is briefed on it; as it was raised at the open day as an example of a potential problem, she should have a briefing note. A farmer manages his farming company, which carries on a farming business. He also manages a separate holiday lettings company that lets cottages adjacent to, but not part of, the farm. He manages both separate businesses from his home. Is it possible that both businesses could be said to be “carried on” from the same premises? They are administered from the same premises, even though the premises used for the delivery of the businesses are clearly separate—in one case the farm premises and in the other case the holiday cottages, which are let out. It is an important point, as there is a danger that many small businesses could be caught unintentionally—I think—by the shared premises test, if the Minister has to tell the Committee that two businesses administered from the same office will be caught by the test.
There are also issues about the definition of “premises”. I am advised that there are a number of different definitions used in different areas of tax legislation and it is not clear what definition of premises is intended to apply in the new section of the Capital Allowances Act 2001. Can the Minister clarify where the relevant definition of premises is found?
Depending on the Minister’s answer to my question about sharing administrative offices, and whether that constitutes the sharing of premises and thus a connection between businesses for the purposes of new section 51E, the Committee may need to address a question of principle. Again, I illustrate the issue by an example. A husband and wife jointly own two companies—a taxi business and a small building firm. Mrs. A operates the taxi company, perhaps from their home or a small office that they rent nearby. Mr. A runs the building business, which is administered from the same office, but obviously will not be carried out, in the sense of delivering building activity, in that office. The taxi business is actively run from the office—taking phone calls, making bookings and so on—while the building business is merely administered from the office, in ordering materials, communicating with customers, and dealing with record keeping, accounts and all the bureaucracy entailed in running any small business these days.
Surely to goodness, we in the Committee do not want to create a situation in which two such businesses have to operate from separate premises to secure a tax benefit in the form of the annual investment allowance. That would be crazy, forcing the husband and wife pair of businesses to operate from separate premises, rent additional offices, pay two sets of overheads and heat and light two sets of offices. I know that the Minister will be worried about the carbon impact. Surely the objective of tax policy cannot be to force people into tax-driven behaviour that is, frankly, economically bonkers. I cannot think of another word for it.
We do not want the tax tail wagging the economic dog, and I hope that the Exchequer Secretary will offer the required reassurance to make it crystal clear not only to Committee members but to those who advise small businesses throughout the land that it is not the intention for businesses operating in that way to be caught by the shared premises condition. If she can be clear about that, I hope that she will also give us a commitment—even if she cannot do anything right now—to look between now and Report at whether anything can be done to the drafting of the shared premises condition to make it absolutely clear that it does not apply to the kind of case that I have given as an example.

Angela Eagle: The schedule introduces rules for the new annual investment allowance of £50,000 a year for business investment—

Frank Cook: Order. May I beg for a little more volume? I am having difficulty hearing. It is part of my job.

Angela Eagle: Having difficulty hearing or hearing in general?

Frank Cook: I need more volume.

Angela Eagle: I am happy to oblige.
The schedule introduces the rules for the new annual investment allowance of £50,000 a year for business investment in plant and machinery. The Government consulted extensively about the design and technical detail of the annual investment allowance through the publication of formal consultation documents in July and December 2007. Respondents to the consultation generally welcomed the proposed annual investment allowance and agreed that it would be of particular benefit to smaller business. As befits a major simplification measure, the Government have taken a light-touch approach to the targeting of the annual investment allowance, which should ensure that the allowance is a welcome and effective investment incentive for the vast majority of businesses.
We have deliberately sought to make the process as simple as possible, but at the same time we must of course protect the Exchequer by ensuring that certain basic rules protect that valuable new allowance from exploitation and avoidance. We have done everything we can to make those basic rules as simple and clear-cut as possible to keep the compliance burdens to a minimum. In outline, the basic rules are contained in the schedule and are broadly as follows. Unless, exceptionally, two or more businesses are controlled by the same person and also fall within one of the two simple tests per related business, the annual investment allowance will be available to any individual carrying on a qualifying activity. That includes trades, professions, vocations, ordinary property businesses and individuals having an employment or office, any partnership consisting only of individuals, and any singleton company or group of companies.
The rules give a business almost complete freedom to allocate the annual investment allowance between different types of expenditure in any way that it chooses. For example, a business may allocate the annual investment allowance against any expenditure on integral features—the new classification that we have just discussed—or long-life asset expenditure. Both qualify for the lower 10 per cent. rate of writing-down allowance.
As well as being financially beneficial, the measure should operate as a proxy for a de minimis provision for integral features expenditure by smaller businesses. In other words, smaller firms may be able to dispense altogether with a 10 per cent. special rate pool if the amount of their integral features expenditure does not exceed £50,000 a year. The rules also allow persons in control the freedom to allocate the AIA between companies in a group, between related companies or between related unincorporated businesses in any way that they see fit. There is no requirement to apportion the allocation of the AIA in any way or on any particular basis; so, for example, in a group of five companies, all of the AIA could be allocated to one company or split between all or any of the five as the group finds most convenient.
The rules provide that a company is related to another company in a financial year—and, separately and independently, that an unincorporated business is related to another in a tax year—if the businesses in question are controlled by the same person and either the shared premises condition or the similar activities condition, or both, is met in the relevant year. Whether commonly controlled businesses share the same premises is a very simple test, and it should be straightforward for taxpayers to understand.
I shall take this opportunity to deal with the holiday let and farming business example mentioned by the hon. Gentleman in his opening remarks. He is right to say that the matter was raised at an HMRC open day, but Her Majesty’s Revenue and Customs confirmed then that the holiday let business and farming business that he described would not be regarded as conducted from the same premises just because the owner of both did his paperwork in the farmhouse. “Premises” has its everyday meaning in that context. In other words, it is not where the paperwork is done; it is where the business is actually carried on. I hope that gives him some of the reassurance that he was after, but he wants to get to his feet, so I am happy to oblige.

Philip Hammond: I am grateful to the Minister for clarifying that point, although there is something of a caveat in the clarification. She implied that what she said is the case because the activity carried on in the farmhouse is de minimis—a bit of paperwork is being done. Perhaps she will address the other example that I used later, which involved a more substantive carrying on of a business: the taxi and building companies carried on by a husband and wife, not from their home but from a rented office. She may not have the answer immediately to hand, but can she confirm that the same rule would apply as in the case of the farming and holiday letting business? That would be a great reassurance.

Angela Eagle: I will come back to that question and try to be as helpful as I can. It is always difficult to give tax advice on the hoof when it will be read by many tax advisers. I do not want to seem as though I am making it up as I go along, but I can confirm at least that administration would not determine the location of the qualifying activity. As with all such matters, a certain amount of checking and considering each example will happen as we go along, in order to clarify the rules. I hope that gives the hon. Gentleman some comfort.
It should be remembered that the vast majority of people do not control a multiplicity of related businesses. The issue may worry some, but it will not be at the forefront of everybody’s mind in every circumstance. In general, the related businesses rules have been welcomed in the accounting press as clear and simple to apply. We always keep such measures under review to see how things develop. However, there has been a general welcome for our approach with respect to related businesses.
The hon. Gentleman spoke about the annual investment allowance. It is important to remember that it is a major simplification for the 95 per cent. of UK businesses that invest up to £50,000 a year. It will provide a valuable cash-flow boost, especially for smaller businesses, as it effectively gives 100 per cent. write-down. It will therefore encourage investment. In that context, it is important to remember that three quarters of small businesses are unincorporated and will therefore benefit from the annual investment allowance without being affected by the increases in the small companies rate. In general, if separate businesses are engaged in separate business activities, even if they are controlled by the same person, they will be entitled to one annual investment allowance each.
The first two of the Opposition’s amendments deal with the basic rules on who can qualify for the annual investment allowance. They seek to extend the allowance to any partnership, including what are called mixed partnerships—those that involve both individuals and companies—and the second of them would extend it also to include trusts.
The restriction on such partnerships and trusts claiming annual investment allowance is carried forward from the existing first-year allowance regime, which the new system replaces. [Interruption.] I hear the hon. Gentleman chuntering, but he made those points himself. He said that just because a rule had been in place in a previous system did not mean that it should automatically be included in the new system. I do not disagree with him in principle. However, it is important to understand the reason for the rules. After careful consideration—[Interruption.] I shall explain why in a moment if the hon. Gentleman will let me finish the sentence.
There was a reason for introducing the rules under the previous system. When they were introduced in 1997, the then Financial Secretary, my right hon. Friend the Member for Bristol, South (Dawn Primarolo), who is now Minister of State, Department of Health, explained to the Finance Bill Committee why the allowances would not be extended to those entities. Her explanation holds good today in relation to the annual investment allowance exclusion. My right hon. Friend said:
“Incredibly complex rules would be required to bring them in, which would open possible abuses of tax-driven options that the hon. Gentleman would deprecate.”—[Official Report, Standing Committee A, 23 April 1997; c.446.]
In other words, there is an issue about fraud avoidance, fragmentation and so on. They are all things that the hon. Gentleman, who is a sophisticated member of the Opposition, knows can be done; he knows what some people will do, and the lengths that they will go to in order to attract investment allowances if they are given the chance. He knows the implications.
In addition, extending the annual investment allowance to partnerships involving trusts would complicate the rules for determining whether a business was in common control—rules that accounting experts have described as
“very simple and easy to understand, and likely to prevent abuse without troubling ordinary businesses.”
I should have thought that that was welcome. I am at some loss as to why the hon. Member for Putney should think that simplification is a good thing yet the hon. Member for Runnymede and Weybridge should say that we ought to extend the rules to partnerships, trusts and mixed partnerships. The latter would create massive complications, bringing company tax as well as income tax rules into play, and creating a whole string of rules to minimise the potential for avoidance. It would be far more complex than the simple rules that we are trying to create, which include the exclusions that the hon. Gentleman seeks to abolish.
Those amendments are likely to increase the Exchequer cost of the measure by approximately £50 million a year. Continuation of the existing exclusions strike the right balance between simplicity and providing a valuable incentive to businesses to invest. I ask the Committee to resist the first two Oppositions amendments.
This group of amendments includes two minor Government amendments. Government amendment No. 146 deals with the basic annual investment allowance entitlement rules and seeks to correct some defective wording by replacing it with a new subsection. The purpose is to ensure that if a business in start up incurs pre-commencement expenditure on or after the relevant annual investment allowance start date in April 2008, that expenditure will qualify on commencement of the businesses qualifying activity. The amendment therefore makes a beneficial change.
The defective wording that amendment No. 146 replaces occurs later in the schedule and so, chronologically, our second amendment—No. 147—should be debated after that. The amendment amounts simply to a technical tweak, and I hope that the Committee will be content for me to refer to it as that. These Government amendments will be of benefit to business and I encourage the Committee to support them.
I confess that the remaining Opposition amendments have caused me some confusion because I had thought that the plans they had published reduced the main rate of corporation tax, for which they tabled an amendment to clause 4, and that they wished to abolish the annual investment allowance. However, these amendments would increase the scope of the annual investment allowance at significant cost.
Amendment No. 202 undermines the fundamental tenet of the way in which capital allowances operate and could lead to more than one business claiming relief for the same expenditure. I heard the comments of the hon. Member for Runnymede and Weybridge, but the amendment would remove the requirement for a business to own the plant and machinery during the chargeable period for which they are claiming annual investment allowance. For obvious reasons, businesses are generally required to own or be deemed to own the plant and machinery on which they are claiming plant and machinery allowances. Where a business does not own the plant and machinery, it may be possible to claim tax relief on contributions to that expenditure, but that is governed by a different part of capital allowances legislation. That legislation prevents the same business from claiming both for capital allowances and for contributions. However, because the amendment would allow businesses to claim annual investment allowance on contributions, it is possible that one business would be able to claim for contributions and the other for owning the plant and machinery. That is clearly not desirable.
Amendment No. 203 would allow businesses to carry forward or back any annual investment allowance—effectively it would prevent the annual investment allowance being annual. The amendment would significantly undermine the simplification benefits of the annual investment allowance and would require businesses to track both their expenditure and their unused annual investment allowance over a number of years. Additional legislation would be required to deal with how to cumulate unused allowances if they were carried forward indefinitely, which would result in unintended behavioural effects, such as businesses deliberately saving up annual allowance entitlement to spend significant amounts in one year. It is likely that that would have a significant cost that would build up considerably over time.
As I said earlier, 95 per cent. of businesses invest less than £50,000 in any one year and the Government have taken a power, about which the hon. Gentleman asked, to vary the level of the annual investment allowance. I can confirm that what is in our mind with regards to that power is perhaps not strict indexation, but it certainly relates to going up, not down. The power to vary that is in the Bill and the hon. Gentleman noticed it. The annual investment allowance represents an incentive for investment and simplification for the smallest businesses in particular. Opposition amendments tend to complicate and with all due respect these amendments leave the annual investment allowance open to abuse in some cases. That is particularly true in relation to the Opposition’s proposal to extend mixed partnerships, which would certainly complicate things and lead to situations in which there might be difficulty in defending the integrity of the allowance.
Therefore, I ask the Committee to support the two minor Government amendments in the group, but to oppose the Opposition amendments.

Philip Hammond: I am grateful to the Minister for clearing up one or two things. I am also grateful for confirmation that the Government’s intention with regards to a broad indexation over time is what we had hoped. To be clear, the Minister suggested that there is some incompatibility between being opposed to something in principle and seeking to probe the way that it will work in practice. The truth is that the Government will get their measures through the Committee—they may even get them through the House, although this subject is something that increasingly consumes our attention. Whatever our principled objections and preferences at strategic level, we must establish how the Government intend to deal with something like the annual investment allowance and we must challenge the individual aspects and workability of that.

Angela Eagle: I suppose that my point was a slightly narrower one. I can understand the hon. Gentleman’s point, it is perfectly legitimate and that is what these Committees are for. However, some of the amendments tabled by the Opposition widen the scope of the annual investment allowance, they do not probe how it would work.

Philip Hammond: The amendment in relation to carry forward and carry back seeks to obtain the Minister’s comments on an issue that has been raised by an outside professional body. We are interested to hear what she says. She has told the Committee that significant costs would be involved, and that is a perfectly legitimate consideration. In my remarks, I raised the concern that investment behaviour may be tax-driven in a way that might be unhealthy and economically inefficient. Although she did not refer to it, I hope that the Treasury will also have considered that as a balancing factor. I accept that there must be a balance drawn in these things.

Angela Eagle: Of course, part of the thinking behind the change in investment allowances in general, of which this is a part, is to align behaviour more with the economic costs in riding down particular investments. Will he comment on his own party’s proposals in this area? Capital allowances are cut in order to fund changes in corporation tax, and that leads to a situation where there are tax disadvantages to investing, as it takes the tax allowances that are given in those circumstances below the economic cost of making the investment.

Philip Hammond: It would be accompanied by a substantial reduction in the headline rate of corporation tax. The other point is that our proposals will be presented in the manifesto at the next general election.

Frank Cook: Order. We are gathered here today in order to make progress on the Finance Bill, not to start sparring about election time. The Minister should have had more sense than introduce it.

Philip Hammond: Thank you, Mr. Cook, I shall attempt not to respond to provocation. The Minister sought to be helpful in explaining how the shared premises test would work. I am still concerned, although somewhat reassured because where one business is functionally run and performed in a premises and another is merely administered from it, it should not be caught by the shared premises test.
Angela Eagleindicated assent.

Philip Hammond: The Minister nods her head, so that clears that up. We are still concerned about the mixed partnership rules. She says that there is substantial scope for abuse, and implies that I know what that scope is. I am sorry to disappoint her, but I do not know what the scope for abuse is—I have been racking my brains trying to think about what mischief one could get up to. She has not addressed the point that the Government have a clear policy of similar treatment for similar economic activity regardless of the legal structure and we are disappointed that she was not able to deal with that.
In relation to ownership, of course it was never intended that double claims of allowances should be made; we were merely seeking to understand why that additional condition had to be introduced into the schedule.

Amendment negatived.

It being One o’clock, The Chairman adjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Four o’clock.